As from 6 April 2017, new tax rules came into force when engaging independent contractors through a personal service company in the public sector. The changes are relevant to both public sector employers and recruitment agencies which supply such workers into the public sector.
To assist them in determining whether the new rules apply, HMRC has launched an online employment status service (ESS). The service is also intended to assist private sector employers and individuals in determining employment status in their particular circumstances.
IR35: starting from general principles…
It is generally well understood that if someone is an employee, the employer is responsible for deducting income tax and national insurance, and accounting for this to HM Revenue & Customs (HMRC). By contrast, if someone is self-employed they have the responsibility for accounting to HMRC for their own tax and national insurance (i.e. it is not the employer's responsibility).
The starting point with contractors is no different, the organisation engaging the contractor must ascertain whether the contractor is an employee or self-employed. Often though, contractors will not be engaged directly and in some industries it is very common for contractors to set up their own personal service company. In these situations the contract will be between the client organisation requiring the services and the personal service company. Alternatively, and commonly, the contractor may provide their services to the client organisation indirectly through another party such as a staffing agency, recruitment agency or an employment business. HMRC recognised the risk that personal service companies and other intermediaries posed to the tax base and came up with what has been known as IR35. In essence this asks whether, but for the interposing of the personal service company, the individual would have been regarded as an employee of the client organisation engaging them. If the answer to this is yes then the personal service company has to account to HMRC for income tax and national insurance on the payments received from that organisation.
New rules applying to the public sector
As IR35 has not been as successful as it ought to have been, from 6 April 2017 the government has introduced new rules, applying only in the public sector, which effectively shift the responsibility for accounting for income tax and national insurance from the personal service company to the public sector employer engaging the services, (or the recruiting agency if one is engaged) rather than the personal service company (these are known as the off-payroll working rules). Where the new rules apply, payments received by a personal service company, directly or indirectly from a contract with a public authority will fall outside the IR35 rules. IR35 will continue to apply in relation to private sector companies which engage contractors through a personal service company.
Public authorities (which include the NHS, councils, armed forces, police. Transport for London, schools and further education colleges) and recruiting agencies will now have to consider whether any particular worker whose services are supplied by an intermediary (service provider), may be deemed to be an employee ("deemed employment"). The intermediary might be a company or partnership in which the worker has a material interest, or another individual.
Under the new rules, the responsibility for determining whether the worker may be deemed to be an employee, also shifts to the public authority engaging the worker, or recruiting agency if one is engaged. In order to do so, they must consider the nature of the work performed under the contract and the terms under which it is performed. The answer is not always clear cut and it is often necessary to seek legal advice. Although there is no obligation to use the new online tool (the ESS) for this purpose, the advantage of doing so is that HMRC will be bound by the output of the service, unless it has been obtained fraudulently.
If the ESS concludes that a worker is in deemed employment, the public authority, or recruiting agency must first make payroll deductions for tax and NICs before paying the intermediary. The classification by the ESS will not necessarily confer employment status on the individual for the purposes of gaining employee protection rights such as unfair dismissal or redundancy. Furthermore, the personal service company/intermediary will remain the employer for the purpose of paying benefits such as statutory sick pay and statutory maternity, paternity or shared parental pay.